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Economic Thought

The other day, I wrote: “[T]he market is always (absent externalities, interference, taxes, asymmetric information, etc) in equilibrium. In some sense this is true*, but it is not the whole story. ” At the time, I promised a future blog post explaining what I meant. This is that post.

The world is always at equilibrium and always in disequilibrium.

What I mean by “the world is always at equilibrium” is twofold: 1) equilibrium analysis, as provided by the standard supply and demand chart, is a useful analytical tool. It provides a person with a good initial understanding of exchange and production and provides reasonable predictions for things like price floors/ceilings, minimum wage, taxes, tariffs, etc etc., and 2) Any given trade, by the virtue of the fact that it is a voluntary trade, can be said to be an equilibrium trade. That is, any trade that occurs between two individuals can be said to establish an equilibrium.

What I mean by “the world is always in disequilibrium” is that there is no “global” equilibrium, no global steady state. Supply and demand curves are functions of endowments, and as trade occurs, endowments change. This necessarily leads to a different set of supply and demand curves, giving new prices and new trading opportunities, leading to new trades, leading to new endowments, leading to new supply and demand curves, on and on.

The article is interesting as a whole. The article begins with a description of the problem:

Too few new antibiotics are under development to combat the threat of multidrug-resistant infections, according to a new World Health Organization report published Tuesday. Adding to the concern: It is likely that the speed of increasing resistance will outpace the slow drug development process.

While the article goes on about these drug shortages, there are no questions as to why too few antibiotics are under development and why the drug development process is so slow. A major reason for the slow development of drugs isdrug regulatory agencies like the FDA!

The purpose of drug regulatory agencies is to slow down development of drugs. The FDA (and its global counterparts) require extensive (and expensive) testing, large sample sizes, and the like, all which slow down the development process. If these regulations were loosened, then the speed of development would increase.

However, this is not to say reducing FDA regulations are necessarily desirable. A cost-benefit analysis would need to be done. Are the costs of delayed drug developments, like what the WHO complains about here, worth the benefits from the FDA regulations? It may be, in which case the slow development will have to be accepted. However, if the costs of the delayed development are too high and exceed the benefits of the regulation, then one would need to accept a higher risk of dangerous drugs getting through in favor of quicker drug development.

In an ideal world, we would have both quick development and safe drugs; there wouldn’t need to be a trade-off between the too. But in this less-than-ideal world we live in everything is scarce, including time. Every second spent doing testing and meeting regulatory requirements is one second less to spend on development of new drugs (and vice versa).

So almost dr of economics- Am I correct in thinking monopolies are bad for consumers, thus must be bad for the economy?

Vanessa’s intuition on this question is good. As Bastiat said, we must evaluate economics through the lens of the consumer. Below is my response to her (sorry for the weird spacing. I don’t know how to fix it):

“Are monopolies bad for consumers?” This depends on what the meaning of the word “bad” means. Monopolies are output restrictiors (that is, they get a higher price by reducing the output they make), and they produce not where price equals the marginal cost of output (ie the “zero profit” level), but the highest price they can get. So, compared to “perfect competition,” the monopoly produces less at a higher price; they are inefficient compared to the perfect competition model. Since “bad” is a judgment call. I’ll leave that up to you.

However, there are some situations where monopolies, as inefficient as they are compared to perfect competition, are the preferable option:

1) In economics, the only way a monopoly can naturally arise is if there are natural barriers preventing entry into the market (eg. high start-up costs, geographical barriers, that sort of thing). We call these, shockingly enough, natural monopolies. The implication of these conditions is that multiple forms of similar firms could not exist at the same time (ie, competition). So, breaking up of this monopoly would not lead to lower prices and more output, but no output at all!

2) Imagine we have a firm who is a major polluter of the water. For every item they produce, they dump a gallon of waste into the local river. Further, assume (unlike the example in item 1 above), that this firm is not a natural monopoly. If an effort to break up this company were undertaken, and output was to increase, then one would see an increase in the pollution dumped into the river! From an environmental POV, this the monopoly is more efficient since it pollutes less!

Just like all economic questions, the answer is ‘as compared to what?” It’s possible, as I explain here, that monopolies may be the preferable option. A blanket statement like “monopolies are bad” or “monopolies are good,” depends on the context in which we’re speaking (and also what “good” and “bad” mean).

[Veetil and Wagner] criticize the standard view, which is that in a large diversified economy the impact of micro level disturbances tend to balance out.

It is absolutely true that, at the macro level, micro level disturbances tend to balance out. That is what’s wrong with macroeconomics. All this aggregation masks the human element that is the core of economics. At the end of the day, we are studying what Mises called “human action”, and what Adam Smith called “a certain propensity in human nature…the propensity to truck, barter, and exchange one thing for another.” We are studying human behavior. Economics is a social science; to aggregate so far as to balance out micro (ie, human) disturbances is to remove the “social” from the social science. Our focus as economists should be on these social aspects, on these individual aspects and the institutions that arise to deal with the human element, of economics. Anything else is, to quote James Buchanan, just applied mathematics; technically interesting, but economically useless.

It is true that economics is a theoretical science and as such abstains from any judgement of value. It is not its task to tell people what ends they should aim at. It is a science of the means to be applied for the attainment of ends chosen, not, to be sure, a science of the choosing of ends. Ultimate decisions, the valuations and the choosing of ends, are beyond the scope of any science. Science never tells a man how he should act; it merely shows how a man must act if he wants to attain definite ends.

Far too many economists, both in Mises’ day and today, make the very mistake Mises warns against: treating economics as a science of the choosing of ends. They consider themselves enlightened for building models that can maximize this or minimize that, and then call for said models to influence policy. But building models like such, as Jim Buchanan said in his 1964 paper What Should Economist Do?, is the purview not of economics, but of applied mathematics. Indeed, anyone with even an elementary level of calculus would find such a task trivially easy.

But economics is not this; it is not merely optimizing some constrained function with some universally desired “social goal.” Economics is the study of exchange; Of competing interests for scarce resources and the institutions that arise to deal with these issues. In short, the study of human action.

Following a natural disaster, one can count on two things in the opinion pages and blogosphere: economists of all stripes decrying price-gouging legislation in a disaster and proponents calling economists immoral for questioning such legislation.

The conversation/disagreement between these two is a microcosm of a much larger discussion: the difference between the normative (subjective) and the positive (objective).

Economics is a positive science. It deals with whatis, not what ought to be. When economists argue that price ceilings (like price-gouging legislation) cause shortages, that is a positive claim: it is a claim of what is. This claim can be empirically tested, but it does not reflect the moral positions or suppositions of the economist. In fact, the claim carries with it no moral implications whatsoever. The claim price-gouging legislation causes shortages carries with it no more or less moral weight than the claim the sky is blue.

Conversely, morality is a normative science. It deals with what ought to be, not what is. When moralists argue that raising prices during a disaster is immoral, that is a normative claim: it is a claim of what ought (not) to be. This claim cannot be empirically tested (although it can be tested to see if it falls into various moral criteria). It reflects the belief structure of the person making the claim. The claim raising prices during a disaster is bad carries with it no more or less empirical weight than the claim the sky is blue is good.

Allow me to elaborate, lest I give the mistaken impression that normative and positive sciences are opposed. Normative and positive are not opposed; in fact, they compliment each other quite well. Normative can prevent positive from becoming abusive (think, for example, our modern sensibilities against eugenic human breeding [normative] despite knowing certain traits are genetic [positive]). But positive can also keep normative from being “pie in the sky,” by explaining how the world is. For example, normative claims like “one should not kill his neighbor,” are all well and good, but the positive claim that “murder happens,” is important to know, too. Knowing the two together brings us to the conclusion that police are needed for the few who do break the law.

To apply this reasoning to disasters, knowing price-gouging legislation makes the logistical system worse is important to know, as it can help inform better forms of aid and legislation.

In short, answering a positive claim with a normative claim will get us nowhere, but the two must be given, and understood, concurrently.

At Cafe Hayek, Don Boudreaux has an excellent post on models and their usefulness in economics. Don’s gist is as follows:

Anyone can devise a model to show almost anything. And economics is filled with widely referenced models that are useless (or worse than useless). The Keynesian Cross comes to mind. So, too, the textbook model of so-called “perfect competition” (which, in addition to being a model in which almost everything resembling real-world competition is either squeezed out or appears as a monopolizing (!) tactic, isn’t even logically coherent – for in the model no room exists for any agent actually to change prices).

The value of an economic model is found in its ability to make the world more understandable. Devising a model is no evidence that the named concepts in the model have anything in reality to correspond to them, or that the model is a useful analytical tool.

In short, the mere fact that a model can show that some preferred policy will increase/decrease economic efficiency doesn’t mean said model is of any analytical use. Sure, the minimum wage in a monopsony may improve the situation, but that information does us no good if the market is not a monopsony.

But let’s build upon this idea. Let’s assume, for the sake of argument, that a given market where a minimum wage is considered is indeed a monopsony. As such, it is theoretically possible that minimum wage would be beneficial, that we would not see, over a given price range, a decline in employment. The poor economist stops here. He might even advocate for minimum wage at this point. But, as Bastiat reminds us, the economist looks for not just the seen effects (ie, what the model says), but the unseen effects, too. The good economist is prompted now to ask “is minimum wage the most cost-effective solution to the problem we are trying to address (in this case, low wages for workers)?” Minimum wage may be an option here, but it may not be the most beneficial option! There may be other options, other institutional arrangements, other agreements that can be reached that will create a better outcome!

Gordon Tullock and James Buchanan drive this point home in their 1962 book The Calculus of Consent. The following is from page 61 of the Liberty Fund Edition of the book (original emphasis):

The most important implication that emerges from the [analytical] approach taken here [in this chapter] is the following: The existance of external effects of private behavior is neither a necessary nor a sufficient condition for an activity to be placed in the realm of collective choice.

While Tullock and Buchanan are discussing externalities here, we can easily generalize their comment to any form of collective action including minimum wage or other methods used to “improve” monopsonies: The existence of a monopsony market resulting from private behavior is neither a necessary nor sufficient condition for a minimum wage to be imposed. The burden of proof requires the good economist to demonstrate that any proposed solution is the best of all available options. Otherwise, the result of the market process, even if less-than-ideal, may be the best choice.

It is easy to play around with models, and any given model may have any number of policy implications. But the mere fact the model suggests Policy A would work doesn’t necessarily mean that Policy A is the best choice. If the costs of imposing A are high, then it may likely end up being a net loss!